Amara Raja’s valuation catches up with Exide’s

Shares of Amara Raja Batteries Ltd have surged 163% in the past year, at a time when shares of market leader and competitor Exide Industries Ltd have declined by 11%. This just reflects the fact that Amara Raja’s business operations have outperformed rival Exide consistently for several quarters. It must also be noted that despite the strong outperformance of its shares, Amara Raja’s valuations have only converged with those of Exide, compared with a wide valuation gap that existed earlier. As the chart alongside shows, Amara Raja’s trailing price-to-earnings multiple was as much as 59% lower than that of Exide’s two years ago.

Back then, Exide enjoyed a near-monopolistic situation in the automotive segment, a growing presence in home inverters and industrial batteries, and operating efficiency with an average profit margin of around 17% for several years. The game-changer was Exide’s capacity constraint at a time when the country’s auto segment was racing ahead. Amara Raja was quick to react, and its market share in the organized replacement battery market rose up to 36% from around 23% a few quarters ago. Exide lost ground as it preferred to retain its original equipment customers when compared with the replacement market. Its market share consequently fell by nearly 10 percentage points to around 45%. This hit its profitability, too, in the process, as the replacement segment enjoys higher margins.

In the near term, Amara Raja’s December quarter operating margin of 16% is likely to remain stable, with slight pressure from rising lead prices in the near term. Also, recent price hikes and a stable rupee should offset cost pressures. While these reasons could hold good for Exide too, its margins need to recover from the 11.3% registered in the December quarter.

Meanwhile, Amara Raja continues to increase capacity both in the automotive segment, where the management expects growth to be better from the second half of fiscal 2014, and in the telecom segment, where a 6-8% growth per annum is likely. Given its strong revenue momentum of 20%-plus over many quarters and cash flows, the Rs.700-800 crore expansion could be easily funded through internal accruals, though it can also afford debt on its books, being a near debt-free firm.

The moot question is: Will Amara Raja’s valuation keep pace with Exide or outperform it? This would hinge on Amara Raja’s ability to sustain operating margins even as it eschews a higher market share. The Street’s estimates of a compounded 20-22% growth in net profit over the next two fiscal years should power its valuations. Even so, one should not underestimate Exide’s slowly improving product mix that could see better profitability.